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Drop in Riskiest Chinese Bank Bonds Signals Alert on Dollar Debt

(Bloomberg) -- China’s dollar-bond market has gone from strength to strength in recent years, but a sign is now emerging that the voracious domestic demand that spurred record issuance is starting to wane.

The riskiest type of bank bonds, known as additional Tier 1 notes or AT1s and which were popular for their higher yields, are now sliding. AT1s sold by the Postal Savings Bank of China, China Zheshang Bank Co. and Bank of Zhengzhou Co. have fallen by at least 2 cents on the dollar since the start of the month.

Behind the drop is a concerted effort by Chinese policy makers to rein in leverage, which has put in the cross-hairs the shadow banking units that borrowed to invest in securities including AT1s. With their longer duration, the securities are also more vulnerable to rising long-term rates, amid expectations for Treasury yields to keep climbing.

"The Chinese AT1, in particular, were priced extremely tight and left little room for error," said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd. "One would expect the asset class to underperform in times of uncertainty coupled with rising rates."

AT1s seek to protect taxpayers from bearing the cost of government bailouts, bringing with them relatively high yields. China’s securities were in such high demand that their rates traded below those of European contingent-convertible bank debt.

That was thanks to "the artificial demand of onshore China from the leveraged structures and now that is being unwound,” said Owen Gallimore, head of credit strategy at Australia & New Zealand Banking Group Ltd.

More broadly, Gallimore sees the focus of Chinese investors in dollar bonds turning toward trading, rather than building up their stockpile of securities.